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Is real estate a good investment?
How to reap the benefits of this asset class — with less risk
Legal Disclosure: Tony Robbins is the Chief of Investor Psychology at Creative Planning, Inc., an SEC Registered Investment Advisor (RIA) with wealth managers serving all 50 states. Mr. Robbins receives compensation for serving in this capacity based on increased business derived by Creative Planning from his services. Accordingly, Mr. Robbins has a financial incentive to refer investors to Creative Planning.
Owning a home is part of the American dream. Whether you prefer a New York brownstone or a house of the white-picket variety, chances are you’ve thought – or dreamt – about turning the key in the front door of your home. But ever since the housing market crashed in 2008, questions have been raised about the benefits and disadvantages of owning your own home – and investing in real estate as a whole.
We caught up with Tony Robbins’ personal financial advisor, Ajay Gupta, to find out what he advises regarding real estate. His first thought that he shared was that “real estate is an important asset class for any investor to consider as a part of their asset allocation.”
But just what exactly is a good fit for your portfolio? Let’s examine a few great options that are available today.
The truth about your primary residence
Your home is an asset, not an investment.
Many people who bought their homes twenty to thirty years ago and have happily seen it appreciate over the years; others bought at the high and lost everything when 2008 hit. The truth is you have no control over what the economy may do, and until you sell your primary residence, you do not know what kind of return you may earn.
According to Nobel prize-winning economist Robert Shiller, U.S. housing prices have been nearly flat for the last 100 years, when adjusted for inflation. Of course, there are times when people selling their homes to downsize are fortunate enough that the house that they are selling has more equity than what they are buying, but unless you’re in a market bubble, that scenario is the best we can hope for.
Therefore always look at your primary residence as an asset. Enjoy your home, create happy memories there, and hopefully it will keep up with inflation. But don’t buy your home as a way to supplement your investment strategy.
Instead, an investment is purely designed to create a rate of return based upon your goals and objectives. In that case, a fiduciary will design individual asset allocations to include: stocks, bonds, commodities, public REITS, “real” real estate, hedge funds and other asset classes, based upon their client’s needs. Perhaps most accessible of all these options is the REIT.
The pros and cons of investing in REITs
Publicly-traded REITs trade on the stock exchange, meaning you can get in and out of them instantaneously – like you could most individual stocks.
There are a few pros and cons to owning REITS:
– Although you own equity in real estate, it fluctuates with the stock market – so you’re not getting any true diversification or non-correlated returns with your stocks.
– However, you do have instant liquidity. If you wanted (or needed) to go to cash you can sell your REITS within a second and have cash available.
– REITs provide an fairly easy income, but do not receive the benefits of depreciation.
– Finally, you do not get to defer the capital gains of a REIT, like you could with a 1031 exchange on physical property. In other words, you will pay taxes on your returns, just as you would on ordinary income.
Ajay Gupta’s top 3 ways to invest in “real” real estate
Within physical real estate, there are various places you may want to invest. These three options are those that Gupta considers to be among the safest places to invest right now – meaning they’re not as susceptible to the fluctuations in economic conditions.
People will always need a place to live. The key to owning apartments is buying in strong geographic locations with a rising or steady population. The brilliance in investing in real estate is demographics. As a whole, millennials are not buying homes like previous generations, causing a rise in the demand for apartments. And, if you buy in the right location, you’ll see the benefits of depreciation – paying very little taxes on the rental income that you receive.
So what are the pros and cons of apartments?
– Usually when you are buying the apartment, you lock in the mortgage rate of your loan. So you’re locking in the largest cost of owning an apartment.
– But you haven’t locked in inflation, so as inflation takes its course, you’re able to raise rent on those apartments, without necessarily raising the costs of running that apartment.
– Of course, there are some costs that you can’t lock in, such as landscaping and property management.
– If you sell the apartments, you can do a 1031 exchange, diverting the capital gains and continuing to benefit from the tax deferral, should you want to stay in real estate.
Now, not everyone can afford to buy apartments, so there are many groups and operators around the country that will buy that $10 million (or even $50 million) apartment complex, and then allow investors to come in and invest in smaller chunks, starting at as little as $25,000. This provides the smaller investor with access to larger operators and larger properties as a co-investor with really strong operators that manage the property.
If you look at the 2008 housing crisis, you’ll see that rental income remained solid, as many people losing or leaving larger homes still needed a place to live. Stable occupancy is correlated with providing the right environment. Another area that remained stable through the crisis was senior housing.
#2 Senior housing
We’ve talked a little bit about senior housing before, and that is because we are currently facing the largest demographic shift we’ve ever seen – a tidal wave of demographic inevitability as Baby Boomers reach their Golden Years.
We have 45 million Americans that are 65 years of age or older, and that number is going to grow to 80 million over the next 2.5 decades. Furthermore, the age 80+ demographic is going to triple over the same period of time. It doesn’t matter if interest rates goes up or down, it doesn’t matter who the President of the United States is, or what is happening in China or Greece; every single day, 12,000 Americans are turning 65 years old. So, if you can own real estate that is catering towards this demographic, you are almost guaranteed occupancy over the next 25 years.
If you can find real estate with a strong operator, investing in senior housing is a great way to benefit from this demographic shift and still own residential real estate. An alternative to co-investing with a strong operator is looking into publicly-traded senior housing REITs. This option provides you liquidity and rental income; however, you won’t receive the same tax benefits. This leads us to our final recommendation.
#3 Triple-net real estate
In triple-net real estate, the tenant is responsible for property taxes, all insurance, and all property upkeep. So if that property needs a new roof, new wiring, or new toilet, the tenant takes care of it. With triple-net real estate you can identify publicly-traded REITs, you can own the real estate directly, or you can co-invest with an operator or fund that specializes in real estate. In the latter option, you give up liquidity but receive some of the other benefits.
With triple-net real estate, you want to focus on long-term leases that are high-quality tenants – like General Electric, Taco Bell, or Siemens, for example. These are big operators who sign yearly leases, meaning you’ve already negotiated today how that rent is going to go up every year with inflation – or based on CPI growth, or plus a fixed 2% growth every year – whatever your specific contract details. The point is, you can take advantage of a rising income stream, locking in the borrowing costs and enjoy your passive income stream.
Triple-net real estate options act much like corporate bonds. However, with corporate bonds you usually receive a rate of return in 2-3% in ordinary income, and if interest rates start going up, chances are your bonds are going to start going down. Whereas with these properties, not only are you getting as much as two times the cash flow, you are also not paying taxes on much of that income. Plus, if there is inflation, your income rises. The biggest trade-off is you are giving up your liquidity, which means this option is not for everyone.
Less than stable real estate
Obviously, not all real estate is a good investment. And buying certain vehicles such as REIT’s can incur high fees so one must beware. Some real estate investments are more susceptible to recessions in economic swings – like office space. Unfortunately, a downturn in the economy results in many businesses closing their doors, leaving the owner with an empty building and no rent coming in. The same is true of shopping centers. As wallets tighten, many shopping centers close.
Which option is right for your portfolio?
Talk to your fiduciary advisory to determine the correct asset allocation for your portfolio, and how real estate may fit in. If you would like to be matched with a fiduciary advisor, visit Portfolio CheckUp.